Abstract:
We examine the profitability of offshoring when quality is costly. Two vertically
differentiated firms buy inputs domestically or offshore cheaply from developing countries.
When the cost difference is independent of quality, equilibrium quality and profits are
unchanged if both offshore. However, if cost difference is declining in quality, offshoring
leads to lower (equilibrium) quality and lower profits for both firms. If only one firm can
offshore, the profits of that firm increases at the cost of its rival. If the offshoring firm is low
(high) quality, equilibrium quality of both firms increase (decline) but this is never an
equilibrium when both can offshore.
